US Dollar Outlook Mired as FX Volatility Returns with Vengeance

US DOLLAR FORECAST: USD PRICE ACTION CATCHES RELIEF BOUNCE AMID EXTREMELY ELEVATED MARKET VOLATILITY

• The US Dollar caught bid on Tuesday and climbed roughly 1.5% measured via the DXY Index as Treasury yields recovered from an unparalleled plunge over recent trading sessions
• Currency volatility, or FX volatility, seems to have returned with vengeance and speaks to systemic uncertainty and risk that looms over the arguably most liquid financial market
• USD price outlook remains contrasted by positive undercurrents like widespread risk aversion and adverse headwinds like aggressive FOMC rate cut expectations

USD price action and the broader US Dollar Index (DYX) staged a recover attempt throughout Tuesday’s session. The Greenback gained roughly 1.5% on balance to reverse nearly half of its downside over the past three trading days, which was accompanied by a recovery in the S&P 500 Index as stocks spiked 5% and yields surged.

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Despite an apparent improvement in risk appetite over the last 24-hours, the VIX Index, or fear-gauge, continues to trade at extremely high levels. The VIX Index, which reflects expected volatility on the S&P 500 over the next 30-days, is perched comfortably above the 45.00 mark.

Readings on the VIX Index have not been this high since the sovereign debt crisis back in August 2011, which highlights underlying uncertainty that hangs over the US stock market. With the VIX Index trading around multi-year highs as investors react to estimated economic fallout from the coronavirus outbreak and crude oil price war, other benchmarks of expected market activity have skyrocketed in a similar fashion.

FX VOLATILITY SKYROCKETS ALONGSIDE VIX INDEX AS CORONAVIRUS CONCERNS RATTLE MARKETS

Chart created by @RichDvorakFX with TradingView

Specifically, currency volatility, quantified by FXVIX, which is a custom index that aggregates 30-day implied volatility readings on the Euro, British Pound and Japanese Yen, has followed the VIX Index higher and remains elevated.

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A high degree of currency volatility is typically associated with periods of risk-aversion, pessimistic trader sentiment and movements into safe-haven currencies such as the US Dollar given its vast liquidity and posturing as the world’s reserve currency.

US DOLLAR INDEX PRICE CHART: WEEKLY TIME FRAME (NOVEMBER 2015 TO MARCH 2020)

Chart created by @RichDvorakFX with TradingView

A generally strong positive relationship can be observed when looking at a weekly chart of the DXY Index overlaid with FXVIX since 2015. That said, the broader US Dollar Index is down more than 3.5% from its recent peak printed earlier this year as the coronavirus begins to infect America and US business activity.

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Rekindled recession risk at home has prompted the Federal Reserve to respond to downside risks faced by the US economy by capitulating to lofty FOMC rate cut bets, which has largely pressured USD price action lower. In fact, the Fed delivered an emergency 0.5% interest rate cut just last week, its first intermeeting rate cut since the global financial crisis and collapse of Lehman Brothers, which sent the US Dollar spiraling to multi-week lows.

DXY INDEX – US DOLLAR PRICE CHART: DAILY TIME FRAME (OCTOBER 2018 TO MARCH 2020)

Chart created by @RichDvorakFX with TradingView

Meanwhile, moves in the DXY Index continue to increase in magnitude, which also underscores FX volatility rising from extreme lows. This is indicated by the US Dollar Index’s 5-day average true range (ATR), a popular barometer used to measure realized currency volatility, which has spiked to its highest reading since January 2017. On that note, USD price action and the broader US Dollar Index has potential to extend its latest rebound as risk-aversion and high degrees of volatility linger over the broader market.

— Written by Rich Dvorak, Junior Analyst for DailyFX.com

Connect with @RichDvorakFX on Twitter for real-time market insight